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Integration of the Finance Function

Integration of the Finance Function. Timothy A. Thompson Spring, 2002. Goals of Integration of the Finance Function. Enhance the quality of strategic business decision-making skills By understanding the effect of those decisions on the value of the company

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Integration of the Finance Function

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  1. Integration of the Finance Function Timothy A. Thompson Spring, 2002

  2. Goals of Integration of the Finance Function • Enhance the quality of strategic business decision-making skills • By understanding the effect of those decisions on the value of the company • By understanding which value drivers are most influential on shareholder value in different situations • By constructing a value-based decision making framework

  3. Expanding skill set • Investment decisions • What are appropriate cash flows to use? • Being consistent in treatment of inflation • What decision rules are/should be used? • How do I incorporate riskiness into my model? • How do I incorporate real asset options into my decision?

  4. Capital structure decisions • Debt/equity • What are the determinants of capital structure choice? • Managerial equity ownership • Do managers have appropriate incentives to maximize shareholder value? • Does managerial equity ownership align incentives appropriately?

  5. Tax shields of debt financing • How much value is added to the firm by the use of debt finance rather than equity? • This value is normally incorporated into firm value through the WACC (weighted average cost of capital) • Alternatively, can calculate a dollar amount using the Adjusted Present Value framework (APV)

  6. Costs of financial distress • Credit rating analysis • Based on financial ratios, predict the bond rating of an investment grade debt • Analyze highly-leveraged transaction using dynamic coverage analysis based on • Forecast free cash flows • Forecast interest and required principal payments

  7. Cost of capital basics • WACC • What determines my cost of capital for a • Project, division, firm? • Beta and CAPM-type models • Peer group analysis • Applications to … • private companies, foreign investments … • Relationship to private equity methods

  8. Corporate valuation models • Models • Multiples based on comparable firms (trading multiples) • Multiples based on acquisitions of comparable companies (transaction multiples) • Discounted cash flow models • Control premiums and Liquidity discounts • When are they appropriate? • How large is reasonable?

  9. Discounted cash flow valuation of corporations • Valuation by components or equity cash flows? • Should I value the equity directly, or estimate the company value (total enterprise value) and subtract net debt • How do I define cash flows for valuation? • What should the length of my forecast window be? • How do I value the company at the end of my forecast window?

  10. DCF corporate valuation continued • Corporate adjustments • What assets do I add to the DCF value of the corporations? • What liabilities do I consider debt (financing liabilities)? • What do I do with preferred stock, minority interests? • How do I handle financial leases/operating leases? • What about contingent liabilities?

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